As some global markets climb to new highs, it is usually prudent to start adopting a cautious (but not necessarily bearish) stance to prepare (early) for the eventual sharp correction. With this aim in mind, and following on last week’s theme of caution with regards to global markets as suggested by the veteran value investor Jeremy Grantham of GMO, I present below an insightful perspective on current markets by another veteran investor- Howard Marks, Chairman of the famed credit manager Oaktree Capital (http://www.oaktreecapital.com/memo.aspx) . To summarise:

-One of the enduring characteristics of the investment world is the capital markets cycle – fluctuating between periods when credit is easily available for anyone in search of capital (resulting in dumb deals getting done), and times when this window shuts down even for the most creditworthy borrowers.

-When the times are good, and investors and lenders want to make investments in larger amounts, they inevitably end up doing dangerous things. Paying a higher price for assets can take the form of weaker deal structures or an increase in risk rather than just higher valuation parameters or lower yields.

-In his memo "Race to the Bottom" written in February 2007, he warned about manifold risks prevailing in markets: the widespread acceptance of financial engineering techniques (CLOs, CDOs etc), an enormous surge in buyouts financed with higher leverage, widespread structural deterioration (i.e. PIK-toggle debt) and an increased willingness to buy riskier securities (i.e. CCC-rated debt and debt to finance dividend payments and stock purchases).

-The memo included an important paragraph – "There’s a global glut of liquidity, minimal interest in traditional investments, little apparent concern about risk, and skimpy prospective returns everywhere. Thus, the price for accessing returns that are potentially adequate (but lower than promised in the past), investors are readily accepting significant risk in the form of heightened leverage, untested derivatives and weak deal structures."

-We are now witnessing another significant upswing in risky behaviour, spurred by the actions of central banks, but which is not anywhere near the same degree as we saw in 2006-2007, as there are no new financial engineering innovations, the growth in derivatives has slowed due to regulatory hurdles and buyout activity is subdued in terms of large deals (though many smaller deals are taking place). However, riskier structures are flowering in the form of "cov-lite" loans, PIK-toggle debt issuance , dividend recaps and stock buybacks.

-Additionally, some of the macro conditions highlighted in the 2007 memo are prevalent today – excess global liquidity, minimal interest in traditional low yielding investments like treasuries and high grade debt and equity, little apparent concern for risk and low prospective returns everywhere.

-Some disturbing news reports and data over the last few weeks:

-Companies are using PIK-toggle structures extensively which helped fuel the buyout boom of 2006-07 (FT).

-More than $200BN (56% of new issues) of "cov-lite" loans have been sold this year, compared with $100 BN in 2007.

-CLOs have made a comeback ($55.4BN this year vs $ 89BN in 2007)and are driving the issuance of weaker structures.

-Bonds rated CCC and below have increased by 11% this year compared with 6% for all junk bonds.

-The average leverage for debt used to finance LBOs has increased from 3.69 in 2009 to 5.37 today (6.05 in 2007).

-Subprime loans (to buy cars) have also made a comeback – doubling from 2010 to a current level of $17.2BN.

-An index of companies with weak balance sheets has rallied by 42% this year, double than that for stronger firms.

-Twitter planned its IPO at a price range of $17-20, then raised it to $23-25 and finally priced it at $26, with the share rising to $44.90 on the following day – a gain of 73%.

-The 23-year old CEO of an 2-year old internet company with no revenues (Snapchat) rejected a $3 billion buyout offer.

-Cash is returning to emerging markets with $1.8BN of stocks sold by Chinese banks in HK, India’s stock market climbing to a record high, Brazil selling its largest dollar bond for $3.25BN and EM IPOs being priced again in London.

-Analyst comments like "The analysis at some point shifts from fundamentals to being purely based on the price action of stocks" is an omen which we must heed.

-However, while there is a significant increase in the acceptance of risk – the psychology is nowhere near as bullish or risk-blind as in 2006-2007. Investors are aware of the uncertainties that abound in the world (U.S. growth, Europe, China, Abenomics, QE tapering, impact of rising interest rates etc) but are being pushed into taking more risk.

-When investors take on added risk – because of optimism or being pushed into it – they usually forget to apply caution with bad implications not just for them – but for the rest of us as well. The markets are riskier now than at any other time since the depths of the 2008-2009 crisis – and they are becoming more so.

-However, it’s not yet time to get bearish because: 1) the quantum of risk (as measured by leverage and new financial instruments) has not yet reached the levels of 2006-07 and 2) valuations parameters are not extended with the P/E on the S&P 500 being at the post-war average of 16. Most assets are fairly (or even richly) priced but are not at bubble-type levels with the possible exception of bonds in general which have been bid up due to central bank actions. But even bonds, issued by money good borrowers with relatively short maturities, will eventually pay-off despite interim mark-downs due to rising rates.

-Buffet (as usual) said it best " the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs". Their motto – "Move forward, but with caution".

A helpful and insightful piece which should focus our attention on managing risk on investment portfolios – "be cautious but not bearish" should be the motto for the next several months. As noted in last week’s letter, continued liquidity provided by global central banks (with the increasingly likely action by the ECB being the main factor) should provide support for the global risk-on trade. It will be critical to keep a close eye on U.S. growth (and unemployment) numbers in 2014, and if they are consistently higher than currently expected (2-3% real growth) it could prompt the market to bring forward the June 2015/2016 date for Fed tightening – causing mayhem in most markets and marking the beginning of the end of the "Great Global Carry" trade (i.e. real estate, high yield bonds, REITS, dividend stocks etc).

The charts below (from Nomura) illustrate the above risk well – showing the increase in credit to the private sector globally, and the rise of residential prices in Asia since 2008 compared with the rise in the U.S. from 2000. The clear outliers are HK and to a lesser extent China – the former is worrisome but is less so with respect to China (as the increased credit has been mainly used to build infrastructure and real assets to cater for ongoing urbanization, and financial repression buys China time).

Ayurvedic Life Style Recommendations – Part I (Dr. Vasant Lad):

Ayurveda lays great emphasis on maintaining an appropriate lifestyle as a means to enjoying a long and mainly disease free life. Dr. Vasant Lad, a former professor of Ayurveda medicine at Pune University in India, is credited with being one of the pioneers in bringing Ayurveda to the U.S. by founding the non-profit Ayurvedic Institute in New Mexico in 1984 (http://www.ayurveda.com/). He has written numerous books on Ayurveda, and also writes on health in a quarterly publication produced by the Ayurvedic Institute. I will serialise a note he wrote a few years ago on the Ayurvedic recommendations on lifestyle.

–Vata, Pitta and Khapa are the three organizations ("doshas") which govern the physical and mental health of an individual – and are present in every cell, tissue and bodily system. Due to changes in diet, lifestyle, emotional state and personal relationships one or more doshas can go out of balance.

-Doshic imbalances create certain signs and syndromes, dependent on which doshas are affected, which can lead to future ailments. It is important to maintain a proper lifestyle to maintain a balance in the doshas before the disease stage develops.

-Ayurveda states that the principle of opposites can used to balance any doshic imbalances and lead to rapid healing. For example, if someone has an imbalanced dry attribute, they can use the oily quality to bring balance. We will now look at applying this principle to the different doshas.

Vata Pacifying Lifestyle:

-Vata dosha is dry, light, cold, rough, subtle mobile, dispersing and irregular. It is characterised by restlessness, constant motion and irregularity in a person’s lifestyle. Therefore it is most important to stay calm and focused and to bring regularity in your life.

-For example, if vata is aggravated one becomes irregular in their habits such as walking, exercising and eating. To counter this, one must maintain a regular routine – simply by waking and sleeping at the same time each day one can significantly control the imbalanced vata dosha. Also, minimize travel, particularly air travel, which can be particularly aggravating to the vata dosha.